Recapitalization is only a first step to address the rot in the banking sector and not the final step. The Government should follow it up with structural reforms to reduce its role in the public sector banks and move towards privatization.
Finance minister of India has announced Rs 2.11 trillion for the public sector banks recently which has come as the relief for the banks which are in deep stress. In this massive plan, govt of India is planning to raise 1.35 trillion rupees through recapitalisation bonds while the banks themselves will raise another 580 billion rupees from share sales. The Indian government has already sought Parliament approval for 800 billion rupees ($12.62 billion) that it plans to spend as part of a two-year recapitalisationprogramme for its state-run banks to help them deal with bad debts and revive credit growth. Indian banks’ non-performing loans have nearly doubled to Rs 8.4 lakh crore since October 2015 when the central bank initiated an asset quality review and out of this, public sector lenders accounted for about 87 percent of the bad loans because of the lack of accountability.
Tried and tested
Recapitalisation using public funds has been tried before. In the 1990s, the government put Rs 20,000 crore into public sector banks and in the years following the financial crisis another Rs 58,600 crore was injected but these recapitalisations did not improve those banks and instead created a moral hazard problem which encouraged these banks to engage in riskier lending practices knowing that the government would bail them out if those loans failed. Since the principal shareholder of public sector banks is the government, there is little market discipline imposed on their loan operations. Also, allocation of funds on the basis of ‘bigger will get better and weaker will survive’ is not necessarily a right thing in every aspect of economy.
Risk
Some people argue that since the government receives additional bank shares from recapitalisation, the potential to sell those shares at a higher price in the future is worth the risk but it is not really the role of a government to engage in a speculative behaviour when it is already moving at a slow pace. We should understand that there are some serious flaws in India’s banking and financial institutions which are at the source of this banking crisis, and instead of pouring billions into a flawed system, govt. should try to fix these flaws. There is no harm in applying the same policy which US or China has applied but there has to be some logic and far sightedness behind these plans.
